Feds fire warning shot over state pensions

New Jersey SEC case is harbinger of things to come

By Geoffrey Lawrence
  • Wednesday, August 25, 2010

A landmark investigation concluded last week in which the federal Securities and Exchange Commission (SEC) for the first time targeted fraudulent accounting within a state pension system. 

The fraud charges filed by the SEC against the State of New Jersey resulted in a cease-and-desist order and sent up a red flag to state policymakers across the country who have underfunded state pension liabilities.

New Jersey has systematically underfunded its pension system for public employees over the past 15 years — while simultaneously increasing retirement benefits. In 1994, New Jersey lawmakers balanced a highly popular and meritorious tax-cut package not by reducing state operating costs but by reducing appropriations to the state pension system. When lawmakers failed to adjust benefit payments, an explosion in the system's unfunded liability was inevitable. 

In 1997, rather than appropriate funds for the pension system, lawmakers borrowed $2.75 billion to deposit into it — the equivalent to making your mortgage payment with a credit card.  Policymakers in Trenton cynically presented this maneuver as feasible by projecting unreasonable rates of return — as much as 12 percent annually — on the borrowed cash. 

Then, after underfunding the pension system for years, New Jersey lawmakers kicked off their 2001 election campaigns by approving a 9 percent increase in retiree benefits and a lowering of the state retirement age to 55. To make the increases in benefits appear to be funded, the pandering lawmakers cooked the books. Ignoring all losses that the pension system had suffered during the collapse of the dot-com bubble, they fraudulently continued to value the system's assets at 1999 levels — a false assumption that has since been perpetuated for years.

This was the context in which the SEC filed charges against the State of New Jersey. The state, said the feds, had "misrepresented and failed to disclose material information" regarding the underfunding of its pension plan when it issued $26 billion worth of bonds between 2001 and 2007.

But the problems uncovered by the SEC extend far past New Jersey's borders. According to former SEC chief accountant Lynn Turner, "There are a lot of states that are significantly underfunded. There's likely to be a dozen that have the same type of problems as New Jersey, and it's not just states but cities too."

The New Jersey case may signal a sea change in that federal oversight agencies — which until now have encouraged fiscal irresponsibility in the states by making bond yields tax-free and providing bailouts — will require more honesty from state lawmakers in the future. "[The SEC] will be looking for other cases," adds former SEC general counsel James Doty. "It's a harbinger that they expect disclosure standards to be scrutinized and be increased."

This should immediately concern states such as New York, California and Illinois, which are known to "employ questionable budget practices." However, lawmakers in the Silver State should pay close attention as well. 

The Nevada Legislature has, to the present, faithfully contributed tax dollars into the Nevada Public Employees' Retirement System (PERS). However, PERS liabilities over the past decade have well outpaced the system's assets, given the continued rise in public employee wages and retiree benefits based on those wages. 

In FY99, the average retired service employee received $18,480 from NV PERS, while the average firefighter or police officer received $27,996. By FY08, those numbers stood at $27,672 and $44,880, respectively.

Because wages outpaced contributions, the system's reported unfunded liabilities increased from $2.4 billion to $7.3 billion over those years. Even worse, if PERS were to use a market-based accounting approach — the subject of debate among pension administrators nationally — the FY08 unfunded liability figure would balloon to at least $33.5 billion. And that figure is based on data from before the 2008 stock market crash.

Nevada lawmakers did make modest reforms to PERS in 2009 as legislative leaders worked out a deal to pass the largest single-session tax hike in state history. Those changes will require slightly higher PERS contributions from local governments and to some extent will moderate the issue of "spiking."

However, until public employee pay and the retiree benefits based on that pay are brought under control, or until lawmakers move to a rational, defined-contribution retirement plan, the state's creditworthiness will continue to erode in direct proportion to its growing pension liabilities.

Nevada is on the road to New Jersey. It's time to pull off.

Geoffrey Lawrence is a fiscal policy analyst at the Nevada Policy Research Institute. For more information visit http://npri.org/.

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